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This blog is a companion to http://vicworld.org, my introspective, philosophical and graphics intensive site for ontological adjustment. Here, on the other hand, I will try to deal with what most people think of as "reality."

Tuesday, April 21, 2009

The Citi share swap

Pretty clearly, Citigroup (despite its vaunted "profits" for the past quarter) is in big trouble.

When the government swaps out its preferred stock in Citi for common stock, a liability is magically transformed into an asset, Citi no longer has to pay the 5% dividend the preferred stock involved, and the taxpayers instantly own 36% of the company. Note that when that happens, the value of a share of Citi is diluted by about a third. Why would the existing stockholders go along with that?

Easy. Two-thirds of something is worth more than all of nothing. They appear to believe -- with good reason, no doubt -- that the only other alternative is to be wiped out.

Mind you, they still could be wiped out, but the prospect becomes a little less likely. The government, which will become the largest single shareholder, will feel a certain obligation to the taxpayers, and work a bit harder to keep Citigroup solvent.

The reasoning of the Obama administration is obvious. Citi is "too big to fail." Citi needs more capital to avoid insolvency. Congress won't provide more capital. Hence, the only way forward is to convert the preferred stock liability into a common stock asset. Clever boy, our Timmy G.

The biggest political problem is figuring out what to do with the voting rights that come with common stock. There are plenty of free-marketeers out there who already are saying that the conversion amounts to partial nationalization. Raise the red flag, comrades!

I am not looking forward to watching Obama & Co. weaseling around, looking for ways to not exercise government's voting rights in Citi. I think that we've had enough problems because shareholders -- private shareholders -- have abrogated their responsibility to exercise control over the companies they own, and left it all to management. I don't see why government, too, should be irresponsible. Summers and Geithner are said to be two of the brightest lights in the field of economics. Let's give them a chance to show just how good they can be -- at Citigroup.